CHAPTER 10

GOVERNMENT SPENDING

Key Terms • per capita• public sector • private sector • transfer payment • grant-in-aid • distribution of income • federal budget• mandatory spending • discretionary spending • fiscal year • federal budget surplus • federal budget deficit • appropriations bill • medicaid • balanced budget amendment• intergovernmental expenditures• deficit spending• federal debt • balanced budget • trust fund

• crowding-out effect • pay-as-you-go provision • line-item veto • spending cap • entitlement

CHAPTER INTRODUCTION

SECTION 1 The Economics of Government Spending

SECTION 2 Federal Government Expenditures

SECTION 3 State and Local Government

ExpendituresSECTION 4 Deficits, Surpluses, and

the National Debt

• Chapter Objectives • Explain why and how government expenditures have

grown since the 1940s.• Describe two kinds of government expenditures• Describe how government spending impacts the

economy.

Section 1: The Economics of Government Spending

Key Terms

– per capita – public sector – private sector – transfer payment – grant-in-aid – distribution of income

Section 1 Introduction

• Government is big business in America. • In fact, all levels of government in the United

States spend more than all privately owned businesses combined.

• Government is a major player in our economy due to its enormous expenditures.

Two Kinds of Spending

• Government spending is for the purchase of goods and services and payments to disadvantaged Americans.

• Goods and services that the government buys includes everything from tanks for the nation’s defense to paper and soap for its employees.

Two Kinds of Spending (cont.)

• Transfer payments include Social Security, welfare, and unemployment compensation. Two kinds of transfer payments exist. If the payment is made from one level of government to another, it is called a grant-in-aid. Subsidies are payments made to individuals or entire industries to encourage or protect a certain economic activity.

Impact of Government Spending

• Government spending affects resource allocation because purchase decisions, subsidies, and transfer payments either stimulate economic activity or affect the factors of production.

• Government spending influences income distribution when transfer payments increase family incomes, federal projects provide or take away jobs, and subsidies give income support to American workers.

• Government spending creates competition with the private sector.

Section 2: Federal Government Expenditures

• Chapter Objectives• Explain how the federal budget is established.• Describe the parts of the federal budget.

Key Terms– mandatory spending – discretionary spending – fiscal year – federal budget surplus – federal budget deficit – appropriations bill – medicaid

– federal budget

Section 2 Introduction

• Taking action on spending bills is but one step in the preparation of the federal budget — an annual plan outlining proposed revenues and expenditures for the coming year.

• Approximately two-thirds of the federal budget consists of mandatory spending— spending authorized by law that continues without the need for annual approvals of Congress.

Introduction (cont.)

• Mandatory spending includes interest payments on borrowed money, Social Security, and Medicare.

• The remaining one-third of the budget deals with discretionary spending– programs that must receive annual authorization.

• Discretionary spending decisions include how much to spend on programs such as the military, the Coast Guard, and welfare

Establishing the Federal Budget

• The federal budget consists of (1) mandatory spending, which includes interest payments on borrowed money, Social Security, and medicare (two-thirds of the budget); and (2) discretionary spending, which includes programs that congress must approve annually (one-third of the budget).

• The government’s fiscal year is from October 1 to September 30.

Establishing the Federal Budget (cont.)

• The second step is House action—Congress has the power to approve, modify, or disapprove the president’s proposed budget. The House sets budget targets for each category of the discretionary budget, then assigns appropriations bills to various subcommittees where subcommittee members study and debate each bill. If the bill is approved in subcommittee, it is sent to the full House Appropriations Committee. If approved there, it goes to the entire House for a vote. All these congressional steps must be completed by September 15 each year.

Establishing the Federal Budget (cont.)

• The third step is Senate action—the Senate may approve the House bill or it may draft its own version. If differences exist, a joint House-Senate conference committee works out a compromise bill.

• The last step is final approval—the House and Senate send the bill to the president for his approval or veto. Once signed, it becomes the official budget for the new fiscal year.

Major Spending Categories (cont.)

• Mandatory spending categories include: Social Security; income security; medicare; interest on the federal debt; some health programs; and veterans’ benefits.

• Discretionary spending categories include; education, employment, social services, transportation, administration of justice, natural resources, and the environment.

the five largest components of federal government spending.

• Social Security• national defense• income security• Medicare• net interest on the federal debt

Section 3: State and Local Government Expenditures

• Chapter Objectives• Explain how state and local governments approve

spending.• Identify the major categories of state government

expenditures.• Identify the major categories of local government

expenditures.

Key Terms

– intergovernmental expenditures

– balanced budget amendment

Section 3 introduction

• State and local levels of government, like the federal government, also have expenditures.

• Like the federal government, these governments must approve spending before revenue dollars can be released.

• The budget process at the state and local levels can be just as complicated as it is at the federal level.

Approving Spending

• Most states approve their budgets using a process similar to the federal government’s process.

• Some states have a balanced budget amendment that requires annual spending not to exceed revenues.

• Local governments empower representatives—the mayor, city council, or county judge—to approve the budget.

Local Government Expenditures

• Local governments include counties, municipalities, townships, school districts, and other special districts.

• The largest categories of spending (about two-thirds of the total) include: elementary and secondary education; public utilities; hospitals; police protection; interest on debt; public welfare; and highways. The other third includes such expenses as housing and community development, fire protection, and parks and recreation.

7 Categories of State Spending

• intergovernmental expenditures• public welfare• insurance trust• higher education• Highways• Hospitals• interest on debt

7 Categories of Government Spending

• elementary and secondary education• public utilities• police protection• Hospitals• interest on debt• public welfare• highways

Section 4: Deficits, Surpluses, and the National Debt

• Chapter Objectives• Explain how the federal deficit is related to the federal

debt.• Relate the impact of the federal debt on the economy.• Describe past attempts to eliminate the federal deficit.• Describe entitlements.

Key Terms •deficit spending•federal debt•balanced budget•trust fund•crowding-out effect

•pay-as-you-go provision•line-item veto•spending cap•entitlement

Section 4 Introduction

• In 1998 the federal budget had its first surplus in 29 years.

• The surplus did not last long, however, as the recession of 2001 reduced tax receipts while politicians simultaneously opted for tax cuts rather than debt reduction. By 2002, federal deficits were back.

From the Deficit to the Debt

• The federal budget has been characterized by a remarkable about of deficit spending – or spending in excess of revenues collected.

• Sometimes the government is forced to spend more than it collects and other times they plan it.

From the Deficit to the Debt (cont.)

• When the budget runs a deficit, the Treasury Department sells bonds to the public to raise money. The federal debt is the total amount the government has borrowed from investors to finance its deficit spending over its long history.

• The debt grows whenever the government spends more than it collects in revenues.

• If the federal government attains a balanced budget the federal debt will not change. *balanced budget : where expenditures EQUAL revenues

From the Deficit to the Debt (cont.)

Figure 10.8

From the Deficit to the Debt (cont.)

• The federal debt differs from private debt because:• we owe most of the federal debt to ourselves, whereas

private debt is owed to others• private debt typically has a repayment deadline, but federal

debt does not; the government just issues new bonds• private debt means individuals give up their purchasing

power as they pay down their debt

*when the federal government repays a debt, the funds transfer to others who gain purchasing power (unless payments are to foreign investors).

Impact of the National Debt

• The federal debt causes a transfer of purchasing power from the private to the public sector. The larger the federal debt, the larger the interest payments, and the more taxes the government must pay.

• If taxes are increased to make the federal debt’s interest payments, it may diminish incentives for Americans to work, save, and invest.

• In selling bonds to raise money, the federal government competes with the private sector for scarce resources, leading to higher-than-normal interest rates (Crowding-Out Effect)

Taming the Deficit

• Congress tried to mandate a balance budget in 1991 through the Gram –Rudman-Hollings Act. GRH failed because Congress passed spending bills in spite of the law.

• The Budget Enforcement Act required that Congress must “pay as it goes.” It must offset any new spending with making reductions elsewhere. BEA failed.

• The Omnibus Budget Reconciliation Act of 1993 only succeeded in reducing the rate of growth of the deficit, not the total deficit. The act combined spending reductions with tax increases, leading to the surplus by 1998.

Entitlements

• Definition: broad social programs that use established eligibility requirements to provide health, nutritional or income supplements to individuals. – Types entitlement programs:

• Social Security• health benefits• aid to the poor• unemployment compensation• Medicaid• federal employee retirement*The rapid growth of entitlements are still a threat to future budget

surpluses.